Regulatory Pressure and Fire Sales in the Corporate Bond Market

55 Pages Posted: 19 Mar 2009 Last revised: 12 Oct 2010

See all articles by Andrew Ellul

Andrew Ellul

Indiana University - Kelley School of Business - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); CSEF - University of Naples Federico II - Centre for Studies in Economics and Finance (CSEF)

Chotibhak Jotikasthira

Southern Methodist University (SMU) - Finance Department

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School; Frank Hawkins Kenan Institute of Private Enterprise

Multiple version iconThere are 2 versions of this paper

Date Written: October 4, 2010

Abstract

This paper investigates fire sales of downgraded corporate bonds induced by regulatory constraints imposed on insurance companies. Regulations either prohibit or impose large capital requirements on the holdings of speculative-grade bonds. As insurance companies hold over one third of all outstanding investment-grade corporate bonds, the collective need to divest downgraded issues may be limited by a scarcity of counterparties and associated bargaining power. Using insurance company transaction data from 2001-2005, we find that insurance companies that are relatively more constrained by regulation are, on average, more likely to sell downgraded bonds. While many bonds do not exhibit a strong price response to the downgrade, those bonds subject to a high probability of regulatory-induced selling exhibit significant price declines and subsequent reversals. These price effects appear larger during periods in which insurance companies as a group are relatively more distressed and when other potential buyers’ capital is relatively scarce.

Keywords: Fire sales, Regulation, Price pressure, Liquidity, Corporate bonds, Insurance companies

JEL Classification: G11, G12, G14, G18, G22

Suggested Citation

Ellul, Andrew and Jotikasthira, Chotibhak and Lundblad, Christian T., Regulatory Pressure and Fire Sales in the Corporate Bond Market (October 4, 2010). AFA 2011 Denver Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1362182 or http://dx.doi.org/10.2139/ssrn.1362182

Andrew Ellul

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

CSEF - University of Naples Federico II - Centre for Studies in Economics and Finance (CSEF) ( email )

Via Cintia
Complesso Monte S. Angelo
Naples, Naples 80126
Italy

Chotibhak Jotikasthira (Contact Author)

Southern Methodist University (SMU) - Finance Department ( email )

United States

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-8441 (Phone)

Frank Hawkins Kenan Institute of Private Enterprise ( email )

Campus Box 3440, The Kenan Center
Chapel Hill, NC 27599-344
United States

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